What Is Cost Allocation?
Cost allocation refers to a process of accounting and recording the full costs of a government service by including its indirect costs or "overhead" in addition to its direct costs.
Direct costs are those that clearly and directly benefit a specific fund or program, such as supplies, materials, staff salaries and benefits, or consultant fees that support a single department or project.
Indirect costs, commonly referred to as "overhead costs" or central services, are for support services that are shared by multiple departments, programs and/or funds, such as accounting, payroll, administrative, or human resource salaries and benefits; information technology (IT) services for the entire municipality; or operating and maintenance costs for city hall or other buildings shared by multiple departments.
For example, the full cost of the Public Works Department includes its direct costs (wages, benefits, maintenance, and operations) plus the indirect costs/"overhead" of support services received from central services (such as accounting, payroll, and IT).
A cost allocation plan distributes these indirect costs to ensure that the respective funds are fairly and accurately paying for the services they receive.
Why Do Local Governments Allocate Costs?
There are a number of reasons that a local government should develop a cost allocation plan or system. A formal cost allocation system can help a jurisdiction:
- Identify the actual cost of services being provided to the citizens.
- Equitably share the costs of shared facilities and support services between departments, programs, and funds throughout the organization.
- Ensure accuracy of cost-based user fees for public services such as utilities, development review, parks, or any other service where the user pays a fee for service.
- Relieve pressure on the general fund by allocating certain general fund costs to enterprise or other funds that receive a benefit from support services.
- Comply with state law and minimize audit issues. RCW 43.09.210 requires that all service rendered by one department to another shall be paid for at its true and full value by the department receiving the service, and that no department shall benefit in any financial manner whatever by an appropriation or fund made for the support of another.
- Get reimbursement for allowable overhead costs from federal and state grants, to the extent that this is allowed by the grant. This usually requires a formal cost allocation plan with internal controls to assure accuracy. Federal monies require strict adherence to OMB’s Uniform Guidance (2 CFR 200).
Basic Steps of Cost Allocation
The key to successful cost allocation is to establish an allocation system that is fair, equitable, and supported by current data. In particular, a cost allocation system should:
- Identify shared facilities or support services
- Identify the costs to be allocated
- Determine the allocation factors/methodology to distribute the costs equitably
- Allocate the costs
- Update and monitor the data and methodology to ensure the allocation remains fair and equitable over time
Step 1: Identify Shared Facilities or Support Services
Your jurisdiction should allocate costs for any services, staff, facilities, or equipment that benefit other funds or departments. Identify within central services or internal service departments any specific services that support multiple funds or departments (such as payroll, accounts payable, utility billing, and facilities and grounds maintenance).
For the purposes of this cost allocation methodology, these costs are referred to as indirect costs or "overhead."
Step 2: Identify Costs
Once you have identified these shared "overhead" functions, compile their total costs using timesheet data or other accounting of actual expenditures associated with this activity.
You can also allocate shared costs using budget projections, although in that case you should include a monitoring component at the end of the year to make sure the budget and the actual costs are within an acceptable range. If you are using projections, the cost allocation plan should define what the "acceptable range" is. For instance, the plan might state that the actual costs must be within 1% of the budgeted costs, or 5%, or somewhere in between.
For instance, below are two simple, fictional examples of cost allocation processes for payroll and facility maintenance.
Example A: Calculating Payroll Costs
The payroll department conducts payroll for all departments, so payroll costs can and should be allocated. To calculate the total cost of providing payroll services, you must calculate the number of hours that each staff member spends on payroll. The most accurate method of calculating this is to use timesheet data. Record the hours each staff member spent on the payroll function, along with their hourly pay rates and the prorated costs of benefits for those employees. Only include payroll hours - if the staff members providing payroll services also perform other duties, do not include the other duties.
If you do not have this level of timesheet data, it will be important to establish a process for hourly timesheet reporting over multiple pay periods to ensure accurate data collection. Conduct a periodic timesheet analysis to determine how the payroll staff spend their time over the course of a typical period (such as a quarter) and update this analysis at least once or twice a year.
| EXAMPLE A: Calculating Payroll Costs |
| PAYROLL SALARY, WAGES, AND BENEFITS |
| Staff |
Hours worked on payroll (annual) |
Hourly rate |
Cost |
| Payroll Clerk |
480 |
$25.00 |
$12,000 |
| Payroll Supervisor |
60 |
$35.00 |
$2,100 |
| Benefits (benefit rate 0.198) |
$2,792 |
| Subtotal |
$16,892 |
| OTHER PAYROLL COSTS |
| Supplies |
$400 |
| Training |
$1,400 |
| Payroll Software |
$250 |
| Subtotal |
$2,050 |
| TOTAL PAYROLL COSTS |
$18,942 |
Example B: Calculating Facility Maintenance Costs
Use the same method to calculate the maintenance costs for facilities that are shared by multiple departments. This example is for a hypothetical City Hall. Be sure to include the costs of materials and any contractors that provide janitorial or other facility maintenance services.
| EXAMPLE B: Calculating Facility Maintenance Costs |
| FACILITY MAINTENANCE SALARY, WAGES, AND BENEFITS |
| Staff |
Hours worked on payroll (annual) |
Hourly rate |
Cost |
| Public Works Maintenance Worker |
200 |
$20.00 |
$4,000 |
| Benefits (benefit rate 0.198) |
$792 |
| Subtotal |
$4,792 |
| OTHER FACILITY MAINTENANCE COSTS |
| Custodial Services Contract |
$3,600 |
| Utilities |
$5,000 |
| Materials |
$2,200 |
| Subtotal |
$10,800 |
| TOTAL FACILITY MAINTENANCE COSTS |
$15,592 |
Step 3: Determine Allocation Factors
Next, determine a fair and equitable way to spread those costs among the various departments, funds, or programs that benefit from the shared services. Use numbers that are easy to gather or estimate and that can be easily updated in the future to keep the cost allocation plan current.
Remove any costs that should not be allocated, costs that can be assigned directly, and any other agreed upon revisions that do not diminish the "cost-basis" of the plan.
Example A (Continued): Determining Payroll Allocation Factor
Payroll costs largely depend on the number of employees your jurisdiction has, so the allocation factor is typically full-time equivalent (FTE) positions. This means that the cost of the payroll function is allocated to the different departments based on the number of FTEs within each department.
| EXAMPLE A: Determining Payroll Allocation Factor |
| Total payroll costs (calculated above) |
$18,942 |
| Total FTEs Citywide |
89.5 |
| Allocation Factor (Total cost / Total FTEs) |
$211.64 per FTE |
Example B (Continued): Determining Facility Maintenance Allocation Factor
Facility maintenance costs depend in large part on the size of the facility, so the allocation factor for facilities maintenance is typically square footage (SF). This means that the facility maintenance costs for City Hall are allocated based on the number of square feet that each department occupies.
| EXAMPLE B: Determining Facility Maintenance Allocation Factor |
| Total facility maintenance costs (calculated above) |
$15,592 |
| Total Facility SF (excluding 200 SF shared space, see note below) |
2,300 |
| Allocation Factor (Total cost / Total SF) |
$6.78 per SF |
| Note: Shared space includes lobbies, bathrooms, etc. that are used by all departments. For this example we excluded shared spaces from the calculation, which effectively allocates those costs based on department square footage. Alternatively, you could do a separate calculation for the shared spaces, potentially based on FTEs. |
Step 4: Allocate Costs
Next, allocate the costs by applying the allocation factors to each department, program, or fund based on their proportionate share (a "one-step" methodology). Again, be sure to thoroughly and consistently document your calculations.
Larger or more complex organizations would typically use either a "two-step" methodology (allocating overhead costs to direct users and to those departments that use the services of the direct users) or reciprocal allocation methodology (allowing for overhead to be allocated back and forth between departments).
Example A (Continued): Allocating Payroll Costs
The payroll overhead costs are being allocated on the basis of FTEs per department. The following chart shows what that might look like based on the size of the departments in this example.
Note that the Finance and Payroll Department cannot allocate all of the payroll costs to other departments and must retain some of those costs internally, because some of the time is spent on payroll for employees within the department.
In this example, Finance and Payroll would retain $1,270 of the payroll costs and allocate the remaining costs to the other departments.
| EXAMPLE A: Allocating Payroll Costs |
| Total payroll costs: $18,942 |
| Department |
FTEs |
Allocation Factor |
Allocated Cost |
| Administration |
3.5 |
$211.64 / FTE |
$741 |
| Finance and Payroll |
6 |
$211.64 / FTE |
$1,270 |
| Parks and Recreation |
8.5 |
$211.64 / FTE |
$1,799 |
| Planning and Building |
11.5 |
$211.64 / FTE |
$2,434 |
| Police |
40 |
$211.64 / FTE |
$8,466 |
| Public Works |
20 |
$211.64 / FTE |
$4,233 |
| TOTAL |
89.5 |
$18,942 |
| Costs and allocation factors are rounded. |
Example B (Continued): Allocating Facility Maintenance Costs
The facility maintenance costs for City Hall are being allocated on the basis of square footage per department. The following chart shows what that might look like based on the how much space each department occupies within City Hall.
| EXAMPLE B: Allocating Facility Maintenance Costs |
| Total Facility Maintenance Costs: $15,592 |
| Department |
Square Footage |
Allocation Factor |
Allocated Cost |
| Administration |
200 |
$6.78 / SF |
$1,356 |
| Finance and Payroll |
300 |
$6.78 / SF |
$2,034 |
| Parks and Recreation |
200 |
$6.78 / SF |
$1,356 |
| Planning and Building |
500 |
$6.78 / SF |
$3,390 |
| Police |
600 |
$6.78 / SF |
$4,067 |
| Public Works |
500 |
$6.78 / SF |
$3,390 |
| TOTAL |
2,300 |
$15,592 |
| Costs and allocation factors are rounded. |
Step 5: Update and Monitor the Data and Methodology
You should periodically review your cost allocation formulas and data to make sure they continue to accurately reflect costs. Incorporating an annual review as a pre-budget development step will help enhance your budget forecasting numbers and update your cost methodology.
Examples of Cost Allocation Plans and Documents
Below are examples of cost allocation plans, studies, and related documents that may be useful, focusing in particular on small to mid-size jurisdictions.
Cost Allocation Plans, Policies, and Studies
Cost Allocation RFPs
Recommended Resources
Below are some useful resources from the State Auditor's Office (SAO) and Government Finance Officers Association (GFOA) to help you create an effective cost allocation system.